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In the crosshairs

With the private funds industry now effectively supervised, US regulators look to be setting their sights on separate accounts. Is their concern really warranted?

Between the Dodd-Frank Act and the Alternative Investment Fund Managers directive, global regulators effectively have created parameters for and achieved oversight of the private funds industry. Now, US regulators look to be turning their attention to the larger asset management industry.

In a 31-page report released earlier this week, the US Office of Financial Research (OFR) raised concerns that the largest asset managers – including such firms as BlackRock, JPMorgan, Deutsche Asset & Wealth Management, Prudential Financial, Goldman Sachs, AXA Investment Managers, MetLife, Invesco and UBS Global Asset Management – could pose a threat to financial stability. It highlighted several areas of concern – from the behavior of separate accounts and a ‘herding’ mentality to leverage, lack of transparency and concentration risk of assets.

Seen as a potential precursor to greater regulatory control, the report comes in response to a request by the US Treasury’s Financial Stability Oversight Council for the OFR to study activities of asset management firms and consider them for greater control under section 113 of the Dodd-Frank Act. Section 113 gives the council powers to designate a non-bank firm as a ‘systemically important financial institution’, which in turn brings with it heightened supervision by the US Federal Reserve and also makes the firm subject to risk-based capital requirements and leverage rules.

The biggest concern the report identifies appears to be separate accounts. It asserts that separate accounts managed by large asset managers are less transparent than those of registered funds, despite separate accounts representing an estimated two-fifths or more of total AUM at such firms. If improperly managed or accompanied by the use of leverage, separate accounts could present systemic risk, the OFR claims.

Another area of concern is “reaching for yield,” meaning the practice of seeking higher returns by purchasing relatively riskier assets for a particular investment strategy. “Depending on the flexibility of investment mandates, managers may take risks that investors do not fully appreciate,” the report states.

On the surface, both assertions would appear to be off-the-mark. Indeed, many pension plans and institutional investors opt for separate accounts in order to have greater control over their investments, including many aspects of strategy and risk. The active involvement of these investors more than likely precludes the use of unauthorized or excessive leverage or risk-taking by the asset manager. In fact, the only entity to which the arrangement is not transparent is the government and its regulators.

It is important to note that at this point the OFR study is nothing more than a report. Any potential action following it is months, if not years, away. Still, faulty assumptions by OFR could lead to misplaced regulation that might adversely impact the separate account business of large asset managers, including those with real estate investment management arms. It is worth challenging these assumptions now before there is less latitude to do so.

PS: In two days’ time Team PEI, including PERE’s Jonathan Brasse, will run the London Half Marathon for Shelter, the homelessness charity. There’s still time to make a donation on our fundraising page. Thank you!